OPINION | Impact investment is disrupting capital allocation in financial markets and reforming the not-for-profit sector.

The response to the global financial crisis has created an explosion of debt-induced liquidity. This has resulted in inflated traditional asset values, causing stretched valuations and increasing concern about the market’s ability to deal with unexpected events. Rising global political instability and populism are only exacerbating the perceived risk.

This is not a new phenomenon. Booms and recessions in the 1890s and 1930s led to policy intervention, including the breaking up of major corporations, increased taxation of monopoly businesses and stronger anti-trust legislation.

So how is the market responding this time around?

Impact investing is one tool helping to transform the way investors think about cross-sector collaboration. Through impact investing, new opportunities are being identified within sectors operating in environmental and social areas, which have not previously been considered rich with potential.

Measuring impact

The rising interest in impact investing can be partially explained by a maturing of the way financial performance is measured. Until the middle of last century, the sole measure of corporate performance was financial return.

During the 1960s and 1970s, measurement of financial risks, through means such as capital asset pricing models and a focus on risk-adjusted returns, became increasingly important in the emergence of asset allocation theory and portfolio diversification.

This decade, we have seen further evolution, with companies being urged to consider financial impact alongside financial risk and financial return. Initially, this was seen in the form of triple-bottom line and environmental social and governance reporting, and was undertaken for corporate social responsibility and reputational reasons.

Now, measurement of environmental and social factors has become more sophisticated and this is helping facilitate how capital is allocated. Already, many organisations’ investment strategies are starting to consider not just the financial return and risk component, but also an impact component.

As corporations redefine their purpose and not-for-profits (NFPs) adjust their attitude towards the financial measurement of outcomes, there is a growing awareness that all investments have an impact, be it positive or negative. This requires an ability to measure, report on and value impact – increasingly in monetary terms.

Focusing on longer-term characteristics opens up opportunities for deploying capital in exciting new ways that create social and environmental value.

Evidence of disruption

Evidence already exists that these types of impact investments do also generate appropriate risk-adjusted market returns. The Goodstart Early Learning deal is one example that demonstrates the potential to build on networks across Australian corporate, government and philanthropic sectors when inspired by a compelling goal to invest for social impact.

Momentum is building from all sectors, with institutional investors responding to stakeholders’ demands that more purpose and impact be built into capital allocation and investment decisions.

ANZ Banking Group is just one case study of a traditional financial institution making an effort to transform itself into a purpose-led organisation, giving increasing consideration to the social impact of its business practices. Given the significance of its footprint across Australia, ANZ doesn’t have the luxury of not getting involved in social and environmental challenges. It must take actions that have a positive impact.

NFP sector evolving

Government has traditionally seen the not-for-profit sector as the vehicle to fund community needs when there has been a perception of market failure. Now, NFPs are also facing massive disruption and reform.

Policymakers are considering new solutions to address the externalities that traditional allocation of capital creates, as can be seen in the emergence of pay-for-outcomes and social bonds.

Impact investment plays an important role in facilitating this confluence of corporate, government and philanthropic capital streams. Through it, we have the opportunity to create social outcomes alongside market risk-adjusted returns that are measurable.

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